On September 24, 2019, the U.S. Department of Labor (DOL) issued its much-anticipated Final Rule amending the federal Fair Labor Standards Act (FLSA) regulations for exemptions from overtime pay requirements for so-called “white-collar” exemptions. By January 1, 2020, employers will need to ensure that their workforces are properly classified in accordance with the Final Rule, which will increase the minimum salary required for an employee to be considered exempt from overtime.
The FLSA mandates that employers pay employees a minimum hourly wage and also pay premium overtime at 1.5 times the employee’s regular rate for all hours worked over 40 in a work week, unless the employees are classified as exempt from these requirements. Executive, administrative, and professional employees may be classified as exempt from the FLSA’s requirements (the EAP exemption) if they meet three tests: (1) the employee must be paid a predetermined and fixed salary that is not subject to reduction because of variations in the quality or quantity of work performed (the “salary basis test”); (2) the amount of salary paid must meet a minimum specified amount, currently set at $455 per week (or $23,660 annually) (the “salary level test”); and (3) the employee’s job duties must primarily involve executive, administrative or professional duties as defined by the regulations (the “duties test”). For an employee to qualify for the Highly Compensated Employees (HCE) exemption, the employee (1) must earn a total annual compensation at or above a certain higher threshold (currently $100,000), which includes payment on a salary basis of at least the EAP-level minimum guarantee; (2) must have primary duties that include performing office or non-manual work; and (3) must customarily and regularly perform at least one of the exempt duties of an EAP exempt employee.
The Obama Administration had previously published a regulation that would have more than doubled the minimum salary level for the EAP exemption, would have increased the minimum compensation for the HCE exemption by a third, and would have instituted further automatic increases every three years (the “2016 Final Rule”). On November 22, 2016, just nine days before that regulation would have become effective, a U.S. District Court in Texas issued a nationwide preliminary injunction against enforcement of the 2016 Final Rule, followed by a permanent injunction on August 31, 2017.
The 2019 Final Rule
The Trump Administration has now published new final regulations that raise the minimum salary levels by a more modest amount, which it believes reflects growth in wages and salaries and the differing ways in which employers compensate their workforces while maintaining the traditional purposes of the salary level test and assisting employers to more readily identify exempt employees.
In the 2019 Final Rule, the DOL formally rescinds the 2016 Final Rule. In what it touts as a “common-sense approach,” the DOL sets the standard salary level by applying the methodology from the 2004 Final Rule—when the EAP levels were first set—to current wage data, resulting in a new standard salary level for the EAP exemption of $35,568 annually. The DOL also decided to increase the HCE exemption to $107,432, setting the annual compensation amount at the 80th percentile of full-time salaried workers nationwide—a level far less than the previously proposed $147,414 annual level. The DOL estimates that, under this change, 1.3 million currently exempt employees will become eligible for overtime pay.
Key Provisions of the Final Rule
The 2019 Final Rule increases the minimum salary required for the EAP exemption from $455 per week or $23,660 annually to $684 per week or $35,568 annually, calculated based on the 20th percentile of wages for full-time salaried employees in the lowest-wage region and/or in the retail industry nationally. The 2016 Final Rule, by contrast, set the standard level at approximately the 40th percentile. The DOL notes in the Final Rule that this new salary level will maintain “the prominence of the duties test,” but will also ensure that salary level alone does not render non-exempt a substantial number of employees who otherwise meet the duties test.
Employers are allowed to use nondiscretionary bonuses and incentive payments (including commissions) to satisfy up to 10 percent of the minimum salary required for the EAP exemption, provided these payments are made on an annual or more frequent basis. This effectively reduces the minimum weekly salary payments to EAP employees to $615.60, provided that on an annual basis the employee’s total nondiscretionary compensation is at least $35,568. This element was introduced in the 2016 Final Rule, provided bonuses were paid at least quarterly. The Trump Administration has retained it with additional leniency on the timing of bonus payments, noting that this provision “appropriately modernizes the regulations” to account for the nondiscretionary bonuses and incentives that have become increasingly common in the workplace. For the HCE exemption, however, employees must be paid a guaranteed salary at or above $684 per week (the default minimum EAP level), with no allowance for nondiscretionary compensation paid at a later date, although nondiscretionary pay can be included in meeting the annual compensation requirement of $107,432 for HCE employees.
Employers are also allowed to make a final “catch-up” payment within one pay period after the end of each 52-week period to bring an employee’s salary to the required level for the EAP exemption. As noted above, employers would be required to pay exempt EAP employees at least 90 percent of the minimum salary level each pay period but could make up the shortfall in a catch-up payment in order to qualify the employee for the exemption. This catch-up payment may come into play if an exempt employee’s commissions, for example, are not sufficient to close the gap between the total amount of the guaranteed weekly salary the employee received and the total minimum salary level of $35,568 annually.
The 2019 Final Rule also increases the minimum total annual compensation for the HCE exemption from $100,000 annually to $107,432 annually. The DOL agreed with the concern of a multitude of commenters that by dramatically increasing the HCE exemption to $147,414 annually, as it had proposed in the Notice of Proposed Rulemaking, the DOL “would be imposing significant administrative costs on employers for a limited effect” because, despite the significant administrative burdens and compliance costs, the vast majority of current exempt HCE employees would remain exempt. The DOL, therefore, calculated the HCE threshold based on the 80th percentile of wages for full-time salaried employees nationally using pooled 2018/2019 current population survey data.
The 2019 Final Rule also revises the special salary levels for workers in U.S. territories and in the motion picture industry.
The DOL asserted its intention to update the minimum salary level for the EAP exemption and the minimum total compensation for the HCE more regularly in the future through notice-and-comment rulemaking, rather than through automatic increases. The effective date for the new minimum salary levels will be January 1, 2020.
What Employers Should Do Now
Employers should act immediately, as they have less than three months to review how the new salary levels will impact their business and their employees and to implement any necessary changes.
The first step is reviewing the salary levels of employees who are currently classified as exempt employees but who earn less than $35,568 annually—or, if the exemption is based solely on being classified as a highly compensated employee, earn less than $107,432 annual minimum compensation. Employers should require employees in this cohort to start keeping records of the hours they work each week. This information will allow employers to evaluate the comparative costs of paying those employees overtime premium pay or increasing the employees’ salary to the new minimum levels. Employers that are unable to increase payroll costs may need to limit the overtime hours worked by these employees and consider transferring some of their duties to other exempt employees earning above the new minimum salary level.
Employers may consider several strategies for implementing these changes:
Finally, employers should also keep in mind that some states and localities, including California and New York state, continue to set a higher bar for exempt classifications under more stringent duties tests and/or higher minimum salary requirements. Employers must comply with both the FLSA and stricter state and local laws and ordinances for an employee to be properly classified as exempt. As a result, this new overtime rule will have relatively little effect on exempt classification in jurisdictions with more rigorous tests for exemption.